macroeconomic mcgrowhill micro ch 4 19e use this one
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04
Elasticity
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Key Terms
End Show
6-2
• Price Elasticity of Demand and
How It Can Be Applied
• The Usefulness of the Total
Revenue Test for Price Elasticity
of Demand
• Price Elasticity of Supply and
How It Can Be Applied
• Cross Elasticity of Demand and
Income Elasticity of Demand
• Consumer Surplus, Producer
Surplus, and Efficiency Losses
Copyright 2008 The McGraw-Hill Companies
Price Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Think about it………
The law of demand says consumers
will buy more when prices go down and
less when prices go up..…
HOW MUCH MORE OR LESS?
DOES IT MATTER?
To whom?
Price elasticity, with respect to demand,
provides an answer..
Key Terms
End Show
6-3
Copyright 2008 The McGraw-Hill Companies
Price Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Measures Responsiveness to Price Changes
Elasticity Coefficient= % delta Q divided by % delta P
P
.01
.02
Elasticity = .5, therefore,
relatively inelastic….
P1
P2
D
Q1 Q2
Key Terms
End Show
6-4
Copyright 2008 The McGraw-Hill Companies
Q
PRICE ELASTICITY OF DEMAND
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Commonly Expressed as…
P
The percentage change in quantity
The percentage change in price
%∆Q d
%∆ P
P2
P1
Key Terms
Q2 Q1
End Show
6-5
Copyright 2008 The McGraw-Hill Companies
D Elasticity is .5
Q
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Price Elasticity of Demand
• Measuring
Responsiveness to Price
Changes
• Relatively Elastic or
Inelastic
• Price-Elasticity Coefficient
and Formula
O 6.1
Ed =
Key Terms
End Show
6-6
Percentage Change in Quantity
Demanded of Product X
Percentage Change in Price
of Product X
Copyright 2008 The McGraw-Hill Companies
Price Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
• Formula Restated
Ed =
End Show
6-7
Original Quantity Demanded of X
÷
Change in Price of X
Original Price of X
• Using Averages
• Midpoint Formula
Ed =
Key Terms
Change in Quantity Demanded of X
Change in Quantity
Sum of Quantities/2
Copyright 2008 The McGraw-Hill Companies
÷
W 6.1
Change in Price
Sum of Prices/2
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Price Elasticity of Demand
• Why Use Percentages?
• Elimination of the Minus
Sign
• Interpretations of Ed
Elastic Demand
Ed =
.04
.02
=2
Ed =
.01
.02
= .5
.02
.02
=1
Inelastic Demand
Unit Elasticity
Key Terms
Ed =
End Show
6-8
Copyright 2008 The McGraw-Hill Companies
Price Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Extreme Cases
Perfectly Inelastic Demand
P
Q
Perfectly Elastic Demand
P
0
6-9
Perfectly
Inelastic
Demand
(Ed = 0)
0
Key Terms
End Show
D1
Copyright 2008 The McGraw-Hill Companies
Perfectly
Elastic
Demand
(Ed = ∞)
D2
Q
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Key Terms
End Show
6-10
•
•
•
•
•
Determinants of Price
Elasticity of Demand
Substitutability
Proportion of Income
Luxuries versus
Necessities
Time
Applications:
– Large Crop Yields
– Excise Taxes
– Decriminalization of Illegal
Drugs
Copyright 2008 The McGraw-Hill Companies
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
The Total Revenue Test
• Total Revenue (TR)
TR = P x Q
Elastic Demand
W 6.2
P
$3
a
2
b
1
D1
Key Terms
0
End Show
6-11
10
Copyright 2008 The McGraw-Hill Companies
20
30
40
Q
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
The Total Revenue Test
• Total Revenue (TR)
TR = P x Q
Inelastic
Demand
P
W 6.2
c
$4
3
2
d
1
Key Terms
End Show
D2
0
6-12
Copyright 2008 The McGraw-Hill Companies
10
20
Q
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
The Total Revenue Test
• Total Revenue (TR)
TR = P x Q
Unit-Elastic
W 6.2
P
e
$3
2
f
1
D3
Key Terms
0
End Show
6-13
Copyright 2008 The McGraw-Hill Companies
10
20
30
Q
Elasticity on a Linear
Demand Curve
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Price Elasticity of Demand for Movie G 6.1
Tickets as Measured by the Elasticity
Coefficient and the Total-Revenue Test
(1)
Total Quantity of
Tickets Demanded
Per Week, Thousands
(2)
Price Per Ticket
1
2
3
4
5
6
Key Terms
7
End Show
8
6-14
Copyright 2008 The McGraw-Hill Companies
8
]
7
]
6
]
5
]
4
]
3
]
2
]
1
(3)
Elasticity
Coefficient (Ed)
5.00
2.60
1.57
1.00
0.64
0.38
0.20
(4)
Total Revenue
(1) X (2)
$8,000
]
14,000
]
18,000
]
20,000
]
20,000
]
18,000
]
14,000
]
8,000
(5)
Total-Revenue
Test
Elastic
Elastic
Elastic
Unit Elastic
Inelastic
Inelastic
Inelastic
Graphically…
Key Terms
End Show
$8 a
7
b
6
c
5
d
4
e
3
f
2
g
1
h D
0 1 2 3 4 5 6 7 8
Quantity Demanded
Total Revenue
(Thousands of Dollars)
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Price
Price Elasticity and the TotalRevenue Curve
$20
18
16
14
12
10
8
6
4
2
Copyright 2008 The McGraw-Hill Companies
Elastic
Ed > 1
Unit Elastic
Ed = 1
TR
0 1 2 3 4 5 6 7 8
Quantity Demanded
6-15
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
Inelastic
Ed < 1
Summary of Price Elasticity of
Demand
Price Elasticity of Demand: A Summary
Absolute Value
of Elasticity
Coefficient
Demand Is:
Impact on Total Revenue of a:
Description
Price Increase Price Decrease
Qd changes by a
larger
percentage than
does price
Total Revenue
decreases
Total Revenue
increases
Greater than 1
(Ed > 1)
Elastic or
relatively
elastic
Equal to 1
(Ed = 1)
Unit or unitary Qd changes by
elastic
the same
percentage as
does price
Total revenue
is unchanged
Total revenue
is unchanged
Less than 1
(Ed < 1)
Inelastic or
relatively
inelastic
Total revenue
increases
Total revenue
decreases
LO2
Qd changes by a
smaller
percentage than
does price
4-16
Price Elasticity of Supply
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Es =
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
Perfectly Inelastic Supply
Market Period:
Not Enough Time to Shift Resources
P
Greatest
Price
Impact
Sm
Pm
P0
Key Terms
D1 D2
End Show
Q0
6-17
Copyright 2008 The McGraw-Hill Companies
Q
O 6.2
Price Elasticity of Supply
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Es =
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
Inelastic Supply
Es < 1
Short Run:
Resources Not Easily Shifted to Alternative Uses
P
Lower
Price
Impact
Ss
Ps
P0
Key Terms
D1 D2
End Show
Q0 Qs
6-18
O 6.2
Copyright 2008 The McGraw-Hill Companies
Q
Price Elasticity of Supply
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Es =
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
Elastic Supply
Es > 1
Long Run:
Resources Easily Shifted to Alternative Uses
P
Sl
Least
Price
Impact
Pl
P0
Key Terms
D1 D2
End Show
Q0 Ql
6-19
Copyright 2008 The McGraw-Hill Companies
Q
O 6.2
Applications of Elasticity of
Supply
• Antiques
• Inelastic supply
• Reproductions
• More elastic supply
• Volatile gold prices
• Inelastic supply
LO3
4-20
Cross Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Key Terms
End Show
6-21
Exy =
Percentage Change in Quantity
Demanded of Product X
Percentage Change in Price
of Product Y
• Substitute Goods –
Positive Sign
• Complementary GoodsNegative Sign
• Independent Goods –
Zero or Near-Zero Value
Copyright 2008 The McGraw-Hill Companies
Income Elasticity of Demand
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Ei =
Percentage Change in Quantity
Demanded
Percentage Change in Income
• Normal Goods –
Positive Sign
• Inferior GoodsNegative Sign
Key Terms
End Show
6-22
Copyright 2008 The McGraw-Hill Companies
Ex,y and Ei
Cross and Income Elasticities of Demand
Value of
Coefficient
Cross elasticity:
Positive (Ewz > 0)
Negative (Exy < 0)
Description
Quantity demanded of W changes in same
direction as change in price of Z
Type of Good(s)
Substitutes
Quantity demanded of X changes in
Complements
opposite direction from change in price of Y
Income elasticity:
Positive (Ei >0)
Quantity demanded of the product changes
in same direction as change in income
Normal or superior
Negative (Ei<0)
Quantity demanded of the product changes
in opposite direction from change in income
Inferior
LO4
4-23
Income Elasticity Insights
• High income elasticities
• Most affected by a recession
• Low or negative income
• Least affected by a recession
LO4
4-24
Elasticity and Pricing Power:
Price Elasticity
of Demand
Total Revenue Te
st
Elasticity on a
Linear Demand Cu
rve
Price Elasticity
and the Total-Rev
enue Curve
Determinants of P
rice Elasticity o
f Demand
Price Elasticity o
f Supply
Cross Elasticity
Income Elasticity
Consumer and Pr
oducer Surplus
Last Word
Key Terms
Why Different Consumers
Pay Different Prices
• All Buyers in a Highly Competitive
Market Pay the Same Price
Regardless of Their Elasticities
• Difficulty in Applying Different
Prices
• Observe Differences in Group
Elasticities
– Business Travelers
– Leisure Travelers
– Discounting for Children
– Different Net Prices for College
Tuition
End Show
6-25
Copyright 2008 The McGraw-Hill Companies
